IBM’s Cutting-Edge Aura Pays Big Rewards

by Kevin Kelleher | March 7, 2012 8:39 am

Like most stocks, International Business Machines (NYSE:IBM[1]) took a hard hit Tuesday, as the broader market slid on concerns of financial instability in Europe and China lowering its economic growth target.

On the face of it, IBM’s sensitivity to slower global growth makes sense: The company makes a third of its revenue from Europe and 23% from Asia. So IBM fell 1.7% on Tuesday, a bigger tumble than the S&P 500’s 1.5% drop and the Nasdaq Composite’s 1.4% decline.

But IBM bulls have reasons to remain encouraged. The company has a strong track record of outperforming not only the broader market but also its biggest competitors. IBM’s share price has gained 22% over the past year and 117% over the past year.

Compare that to the S&P 500, which has risen 5% over the past year and declined 4% over the past five years. Or to Oracle (NASDAQ:ORCL[2]), which has fallen 4% in the past year and risen 80% in the past five years. Or Hewlett-Packard (NYSE:HPQ[3]), which is down 43% over the past year and down 38% in the past five years.

Of course, past performance, no matter how strong, doesn’t always guarantee future gains. But IBM’s ability to steadily outpace the U.S. stock market shows it can navigate successfully through good times and bad. And at a time when the markets are jittery because no one knows for sure what 2012 has in store, that’s not a bad skill to have.

And despite the stock’s gains, IBM is still valued moderately. It’s trading at 15 times its trailing 12-month earnings and 12 times its forward earnings. The S&P 500 is trading at 16 times its aggregate trailing earnings.

IBM has risen because of its ability to deliver steady earnings growth. Earnings per share have risen at an annual rate above 10%[4] for every quarter of the past five years except one — the first quarter of 2009, one that nearly every company would prefer to forget. And even in that quarter, EPS grew by 4%.

Of course, IBM’s success is nowhere near Apple‘s (NASDAQ:AAPL[5]), whose stock has risen more than 500% over the past five years. But there is an analogy: Apple’s brand has become nearly synonymous with innovation and quality in consumer technology. People pay more for Apple products because they believe the experience of using them is worth it.

IBM is the company that comes closest to replicating that brand image in the realm of corporate technology — a $285 billion market, according to Gartner. IBM telegraphs its status as an innovative brand with R&D projects such as its work on building a quantum computer[6] or having its Watson supercomputer compete on Jeopardy!.

On Tuesday, IBM said Watson, which already offers its computing prowess to health-care companies like WellPoint (NYSE:WLP[7]), will help Citigroup (NYSE:C[8]) analyze customer, financial and economic data. Citigroup may be the first of several Wall Street firms to employ Watson’s technology. According to Bloomberg, one analyst estimates Watson alone will add $2.65 billion to revenue and 52 cents to EPS[9] in 2015.

That’s not bad, but the real value of Watson and research in fields like quantum computing is that it lends IBM the aura of cutting-edge technology. IBM couples that aura of innovation with its status as a software giant that can help other companies bring new technologies into their enterprises in a risk-free way. It makes IBM’s software look as impressive as a high-def iPad.

Tellingly, IBM is pitching its Watson technology as cloud-based. That fits with the company’s efforts to offer cloud computing to companies that are enamored with a buzzword they may not understand very well, but that seems fraught, on the surface at least, with concerns about security and reliability.

IBM’s Watson announcement coincided with another, less glamorous announcement of its SmartCloud software suite[10], which is aimed at companies and governments that want more control developing private cloud environments. IBM says the SmartCloud service can be deployed in a matter of minutes.

Also on Tuesday, IBM released a survey of 572 companies that showed that while 13% of them have substantially implemented cloud software, 41% expect to do so within three years. And 90% will have piloted or implemented cloud computing by then.

So while IBM’s stock suffered a 1.7% setback on Tuesday, it also gave investors some good reasons to expect continued earnings growth even in the uncertain months ahead. The cloud is catching on in global corporations. And IBM is positioning itself as a company that can bring others into it.

Earnings per share have risen at an annual rate above 10%: http://ycharts.com/companies/IBM/eps_growth#series=type:company,id:IBM,calc:eps_growth&zoom=5&startDate=&endDate=&format=real&recessions=false